Wash Sale Rule
IRS rule disallowing tax losses when substantially identical securities are repurchased within 30 days
What is Wash Sale Rule?
Wash Sale Rule The wash sale rule is an IRS regulation that disallows the tax deduction of a capital loss when a "substantially identical" security is repurchased within 30 days before or after the sale. Originally designed to prevent investors from harvesting tax losses without actually changing their economic position, the rule affects active options traders significantly. The 30-day window is bidirectional: you cannot deduct the loss if you bought the same security in the 30 days before the loss OR if you buy it within 30 days after. The "substantially identical" definition includes: - The same stock - The same option series (same underlying, same strike, same expiration) - Options on the same underlying with similar exposure (in some interpretations) When a wash sale triggers, the disallowed loss isn't permanently lost — it's added to the cost basis of the replacement security. The recognition is deferred until the replacement security is sold without triggering another wash sale. Example of wash sale in stocks: - January 5: Buy 100 shares of AAPL at $185. - January 15: Sell 100 shares at $175 — $1,000 loss. - January 25: Repurchase 100 shares at $172 — within 30 days. **Wash sale triggers.** - The $1,000 loss is disallowed for current tax year. - The $1,000 loss is added to the cost basis of the January 25 purchase: new basis = $172 + $1,000/100 = $182 per share. Wash sale in options is more nuanced because the IRS rules around "substantially identical" options are less clearly defined. Generally: - Buying and selling the same strike/expiration option triggers wash sale on the same series. - Rolling a covered call (buying back the short call and selling a new one) is typically not a wash sale because the new option has different terms. - Closing a losing short put position and immediately selling shares at the underlying strike could trigger wash-sale considerations on the equity side. Active options traders face wash sale rules especially in: - **Rolling losing positions**: rolling a put credit spread that's losing money can trigger wash sale on the closed short put. - **Trading the same underlying repeatedly**: scalping a stock with both stock and options positions creates compound wash sale exposure. - **Year-end tax-loss harvesting**: planning to harvest losses in December while continuing to trade the same underlying is tricky. Common mitigations: - Wait 31 days before re-establishing positions you're harvesting losses on. - Switch to a similar but not "substantially identical" instrument (e.g., move from AAPL to MSFT, or from SPY to VOO). - Use options on different underlyings or significantly different strikes/expirations. - Use a tax professional for complex wash-sale situations. The wash sale rule applies to taxable accounts only. IRAs and other tax-advantaged accounts are exempt — but the practical reality is that losses in tax-advantaged accounts aren't deductible anyway.
Complete Definition
The wash sale rule is an IRS regulation that disallows the tax deduction of a capital loss when a "substantially identical" security is repurchased within 30 days before or after the sale. Originally designed to prevent investors from harvesting tax losses without actually changing their economic position, the rule affects active options traders significantly. The 30-day window is bidirectional: you cannot deduct the loss if you bought the same security in the 30 days before the loss OR if you buy it within 30 days after. The "substantially identical" definition includes: - The same stock - The same option series (same underlying, same strike, same expiration) - Options on the same underlying with similar exposure (in some interpretations) When a wash sale triggers, the disallowed loss isn't permanently lost — it's added to the cost basis of the replacement security. The recognition is deferred until the replacement security is sold without triggering another wash sale. Example of wash sale in stocks: - January 5: Buy 100 shares of AAPL at $185. - January 15: Sell 100 shares at $175 — $1,000 loss. - January 25: Repurchase 100 shares at $172 — within 30 days. **Wash sale triggers.** - The $1,000 loss is disallowed for current tax year. - The $1,000 loss is added to the cost basis of the January 25 purchase: new basis = $172 + $1,000/100 = $182 per share. Wash sale in options is more nuanced because the IRS rules around "substantially identical" options are less clearly defined. Generally: - Buying and selling the same strike/expiration option triggers wash sale on the same series. - Rolling a covered call (buying back the short call and selling a new one) is typically not a wash sale because the new option has different terms. - Closing a losing short put position and immediately selling shares at the underlying strike could trigger wash-sale considerations on the equity side. Active options traders face wash sale rules especially in: - **Rolling losing positions**: rolling a put credit spread that's losing money can trigger wash sale on the closed short put. - **Trading the same underlying repeatedly**: scalping a stock with both stock and options positions creates compound wash sale exposure. - **Year-end tax-loss harvesting**: planning to harvest losses in December while continuing to trade the same underlying is tricky. Common mitigations: - Wait 31 days before re-establishing positions you're harvesting losses on. - Switch to a similar but not "substantially identical" instrument (e.g., move from AAPL to MSFT, or from SPY to VOO). - Use options on different underlyings or significantly different strikes/expirations. - Use a tax professional for complex wash-sale situations. The wash sale rule applies to taxable accounts only. IRAs and other tax-advantaged accounts are exempt — but the practical reality is that losses in tax-advantaged accounts aren't deductible anyway.
Example
Trader sells 100 shares of SPY for $200 loss on March 10. On March 25, buys 100 shares of SPY back at higher price. Wash sale triggered — $200 loss disallowed for current year. The $200 is added to the new SPY position's cost basis, deferring the loss recognition until that position is eventually sold (without triggering another wash sale).
Related Terms
Frequently Asked Questions
What is the wash sale rule?
The wash sale rule is an IRS regulation that disallows the tax deduction of a capital loss when a substantially identical security is purchased within 30 days before or after the sale. The disallowed loss is added to the cost basis of the replacement security, deferring recognition until that position is sold.
Does the wash sale rule apply to options?
Yes. Buying and selling the same option series (same underlying, strike, expiration) can trigger wash sale. Options on the same underlying with substantially similar exposure may also trigger it in some interpretations. Rolling covered calls is typically not a wash sale because the new option has different terms.
How do I avoid wash sale rule violations?
Wait 31 days before re-establishing positions you're harvesting losses on. Switch to similar-but-not-identical instruments (AAPL → MSFT, SPY → VOO). Use options on different underlyings or significantly different strikes/expirations. The rule does not apply to IRAs and other tax-advantaged accounts.
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